Abstract:
This study examines the determinants of stock returns of Colombo Stock Exchange (CSE)
and London Stock Exchange (LSE) for the period spanning from 2000-2012. The study
applies a panel data approach in a multifactor assets pricing framework using seven firm
specific variables and nine macroeconomic indicators. The fitted one-way fixed effects
firm factor regression indicates that Return on Assets (ROA) and sales growth rate play a
significant role in explaining variation in stock returns in Sri Lankan companies while oneway random effect firm factor model in UK shows that E/P ratio, B/M ratio, fixed assets
growth rate, size and ROA are the most dominants priced factors in London listed
companies. The explanatory power of regressions increases considerably when we
incorporate macroeconomic indicators controlling for firm effects and results show that
inflation, GDP and exchange rate remain leading predictors of stock returns variation in
both CSE and LSE whereas unemployment and Foreign Portfolio Investments (FPI)
become statistically significant only in CSE. Thus, the results do not reveal big differences
between the systematic and unsystematic risk factors which are priced in both the LSE
and the CSE stocks. It can be concluded that the stock markets of the UK and Sri Lanka are
more sensitive to macroeconomic changes and the findings of this study disagree with the
predictions of Fama’s (1970) semi-strong form of the market efficiency. Hence, it seems
that, based on the publicly available information, the investors can make abnormal profits
through stock trading strategies and the multifactor assets pricing models work
effectively in both the CSE and the LSE.
